Throwing in the Towel

When Georgia Pacific's Chairman Pete Correll oversaw the sale of this venerable company to the Koch family (prounounced "Kock"), some mystifying questions remain unanswered as to what one should infer from the sale itself, and what Mr Correll meant in his comments surrounding the transaction. Apparently it seems, Mr Correll chose to sell due to increasing frustration over the markets' rating of his comapny's shares. The FT of London quoted him as saying: "The credibility of CEO's in this country is at an all-time low and we're spending a lot of time trying to convince the world that we are doing the right thing."

The first thing that went thorugh my head upon reading this quote was Sheryl Crow sadly pining with an accompanying pedal steel guitar ... "No one said it would be easy......No one said it would be this hard....". To be fair to Mr Correll, he ONLY took down USD$4,188,000 in cash compensation last year which really is a paltry sum compared to CEO's of other public companies of similar size so he may have reason to be bitter. And perhaps his board turned turn his request for a gross-up. Although this may have been a hidden agenda, it was not his stated reason for (seeking?), agreeing, and awarding the venerable Georgia Pacific Corp. to the rabidly conservative Kock (sic?) family.

No. His stated reasons were (to paraphrase him): (1) my stock price is not high enough (2) too much of my chiefly time is spent trying to get it up (the stock price, that is), and (3) no one seems to believe in me or have confidence in my decisions. My questions are: (a) Do the Koch's know something the rest of the world doesn't? (b) is one in the hand worth two in bush? (c) is there not something strange in Mr Correll's very quick agreement to the bid, and stated intention to lead the company on behalf of the Koch's after the deal closes? It seems that my "questions" relate roughly in order to Mr Correll's reasons, but they clearly merit some more detail than that.

First, Mr Correll opined, "My share price is too low". My initial thought to this was that maybe he's in the wrong business. Maybe his eye for value is so good, he should be a portfolio manager, since the difference between "too little" and "too much" seeems a paltry sum. But upon closer examination, with GP at approx. 1.4x book, 5.2x 12-month trailing cash flow, 9x trailing free cash flow, and 6.5x trailing ev/ebitda, it's hard to argue that he's wrong (about it being cheap) or that his "frustration" unwarranted. On the other hand, GP has lots of debt, and it's cost of capital is high, while it's returns are low relative to assets. And I've certainly seen better balance sheets. With their BB+ rating, and an avg 250bp spread to US Treasury's on more than $9bn of indebtedness, it sucks up a lot of EBITDA, and raises dramtically raises cost of funds. As a result, many would categorize it as a destroyer of value in the Stern-Stewart sense. But then again, modernity has blessed GP shareholders with the near-perfect capital structure for our times where inflation is increasing, assets are dear (and becoming dearer!), and paper (cash in particular) is duff. So rather than whining about the market valuation, he had the perfect stump speech to give to investors in order to continue talking it up: lots of assets with lots of debt and lots of present and future cash flow - including the "free kind", after creditors have been satiated, that is.

But what if it IS low. So what? Well if you believe Mr. Correll, the market is wrong and therefore inefficient. But THAT is neither Mr Correll's fault nor problem (unless he can convince the Johnson Family to up Fido's stake from a paltry 3% to the 15% that is similar to things they like. IF THAT is his problem, then he best be tuning up his stump speech to include things like "the short run vs. the long run", "the investment horizon of the typical GP project (10yrs) versus the typical institutional stock market investment horizon (of 2 quarters)". He can also talk about "price-making" versus "price taking". He can also talk about how chaos would reign, and capitalism would be disintegrate if management were really measured quarter-to-quarter. Finally, he could speak of patience, Warren Buffett, Joe Steinberg, and how investors should be emulating these giants by beating their own path - especially where the assets are good, and the business is sound.

But what if you believe the market (which by the way one ignores at their peril IMHO)? Maybe it's cheap for a reason, and should be cheap and thus the current price is "fair-value". Maybe 'ol Joe is just "talkin' his own book"? Asbestos, loadsa' debt, poor returns however they're measured, management who can't seem to decide whether its a buyer or seller of assets. Maybe, at 250bp's over, it's the debt that's attractive, not the equity? Maybe, the market is saying that the housing boom is over with direct consequences for building materials, or maybe pulp prices will rise, or deflation is just around the corner which will wreak havoc with leveraged balance sheets everywhere. In such a situation, GP may not only be fairly-valued, but over-valued, from the perspective of the shareholder. All quite plausible, the answer which we'll find out in a few years time.

What's an investor to believe? Joe says $35 is "too cheap", so cheap that he is despondent and his secretary has to hide all the sharp objects in order to keep tragedy at bay. But $47 (the bid price) is "too much". And we can infer that it's "too much" because as fiduciary on behalf of shareholders, he's willing to rapidly and unequivocally "hit the bid". One has no other choice to conclude then that it must be unequivocally too much, such that (1) he is unable to wring further savings or efficiencies out of the company; (2) he thinks margins are as fat as they can get (3) he cannot foresee higher end-prices for tissues, paperboard, or building materials (4) he cannot foresee or envision a probable scenario for growth of GP's mainlines (5) he thinks the capital structure of the company is a liability rather than an asset. Yet despite any or all of these possibilities, no one is forcing a sale. Maybe Joe has confused investors' frustration with the viccissitudes and variability of Mr Market with disappointment in the company and it's chairman (i.e. himself)? Or perhaps it's just a self-esteem problem?

Yet the Koch's are keen. That's precisely what makes a market. Willing buyers and sellers at a price. But one would be foregiven for asking the question: What do the successful owners of America's largest private enterprise know that Joe Correll, the market and "the world" for that matter doesn't? It would be worth meditating upon this question if for no other reason than the Koch's are the owners of the largest private business in America, and you/I/we, are not. And one doesn't arrive (and stay) in this position with some amount of shrewdness (not to mention political campaign contributions and some good tax accountants).

The Kochs, you see, own assets (first and foremost energy & petrochemical). Effectively, their enterprise works like this: They earn paper dollars from the cash flow of their existing assets in excess of the rate of interest on their debt and then use the surplus generated to borrow more money in order to buy more assets. And so on. In the 1920s they called it pyramiding. (And it worked, until 1929).

Like the Kocks, GP owns large amounts of assets. They also have copious amounts of debt though quite sufficient cash flow to service it, and also provide a respectable return for shareholders (though not enough it would seem by shareholders approval of the sale). GP shareholders owned the assets. And Joe Correll, as Chairman and CEO was supposed to be protecting the interests of GP shareholders.

Back to the Kochs. They like swapping depreciating paper (other people's money) for other peoples' hard assets. They are willing to do so at a premium to what the market thinks the current price should be - particularly in "out-of-favor" industries. Mr Correll must therefore believe that shareholders will be better off with paper today (cash) at a slightly higher price, than with the assets (and their cashflow) tomorrow. In other words, "one-point-five (1.5x) in hand" (the proposed takeout multiple) is worth 2-point-something (2.0x) or more in the bush".

Interestingly, Mr Correll will be "chaperoning" these assets to their new owners out of some [altruistic?] responsibility to employees and the new owners. A cynic might suggest that he's been double dealing, not to mention double dipping (golden parachute severance + golden handshake in one deal!) though an honest midwesterner would say it can't possibly be for the upside that the new owners might afford him, since as CEO has has obviously wrung as much value for existing shareholders out of the company as was possible. For if there was more to wring, then he wouldn't (or shouldn't) be selling it to the Kochs at that price since this would have breached his fiduciary duties, not to mention shone a light on his failure as CEO.

It's all rather puzzling. One day, maybe Mr Correll will publish his memoirs and learn "the inside story". On second thought, we should hope he spares potential readers honor. But the nagging question remains: The Kocks are paying above market so they must be bullish right? The real question, is: bullish on what? It might be bullish on economies of scale (but they are a minnow in GP's industry by comparison). Or they might be bullish on the economy...more bullish than Mr Correll and his shareholders. Perhaps, however, there is a third and more interesting reason. Perhaps, given their good republican credentials, and their close relationship with the Bush family and his administration, the Kochs are bullish on continued deficits and monetization thereof, and loose monetary policy to insure there aren't any nasty surprises. There is an old saying "Neither a borrower nor a lender be..." But this was obviously truncated from the original which continued "...unless one has reliable information on the future course of fiscal and monetary policy in which case you should back up the truck and lever up."